There’s no doubt that economic conditions are making life tough for small businesses, especially if they need to raise funds for expansion. But if getting a loan from a bank is proving difficult, there are other options for raising money.
There is plenty of gloom about. The turbulent global situation means consumers are reluctant to spend and businesses lack cash or they’re saddled with too much debt. However, Council of Small Business of Australia executive director Peter Strong says small and medium-sized enterprises (SMEs) are very diverse, so not all of them are finding it tough. But those in retail, tourism and manufacturing have been hit hard by the strength of the Australian dollar and the fact that people are turning frugal.
“For all SMEs, wages are going up and there remains plenty of red tape,” Strong says. “This is affecting cash flow and a lot of businesses are needing to make decisions around staffing levels.”
Strong says to help with cash flow, SMEs are talking to their suppliers and trying to negotiate favourable payment terms. “They are also cutting back on goods and stock levels are falling,” he says. “I find small businesses are also trying to diversify more – for example, putting coffee-making facilities into retail outlets as well as going online.”
Invoice discounting suits those businesses that are looking to grow or manage their cash flow more effectively.– Lee Clarke, Allianz
SMEs that need funds and can’t secure bank loans tend to spend up to the limit on credit cards. But there are alternative funding sources to turn to, including debtor finance, vendor finance, leasing, inventory financing and chattel mortgages.
Debtor financing is also known as cash-flow finance, receivables funding, invoice discounting and debt factoring. It involves having credit secured against sales invoices.
The latest figures on the receivables finance industry, released by industry body the Institute for Factors and Discounters of Australia and New Zealand, show a rise in receivables finance to Australian businesses in the June quarter of this year to A$15.2 billion, up 6 per cent on the March 2011 quarter and 7 per cent on the June 2010 quarter. The total receivables finance provided to businesses between June 2010 and June 2011 was A$60.6 billion.
One of the main players in financing products is Allianz Finance, which provides confidential invoice discounting. Allianz general manager Lee Clarke says instead of waiting 30 to 60 days for an invoice to be paid, a financier can advance up to 80 per cent of the value of invoices within 24 hours.
“Upon the invoice being paid by the debtor, the financier will release the remainder of the value – in this instance 20 per cent, less interest charges,” Clarke says. “Allianz finds that invoice discounting suits those businesses that are looking to grow or manage their cash flow more effectively.”
Invoice discounting differs from factoring (which tends to be offered by second-tier firms) in that the latter includes a collection service and the financier’s relationship with the business is disclosed to the debtors.
“Traditionally, factoring is more suited to small or start-up businesses that can use the services of the financier to help them collect the invoices and, as a result, it tends to be more expensive than invoice discounting,” Clarke says.
He says solutions such as invoice discounting are becoming more popular with SMEs, particularly given the tightening of bank lending after the global financial crisis. In addition, most bank products require asset backing. Invoice discounting is one way to fund businesses that lack bricks and mortar security.
“There are businesses that just don’t have property assets and the owners don’t want to have to put their family home up as security, so these types of products are fantastic for them,” Clarke says.
In terms of growth, receivables financing is growing more quickly.– Paul Dowling, East & Partners
Banks also tend to cap the amount they will lend small businesses and this can create problems, according to Clarke. “For example, a business might have a A$1 million overdraft, but needs funds to grow because it wants to double its turnover,” he says. “In order to increase an overdraft, further security will generally be required. For some businesses, such as recruitment companies, the biggest asset will be the expected revenue stream from their clients, not necessarily property assets.”
East & Partners, which carries out research into SMEs, says access to credit remains problematic for small businesses. Principal analyst Paul Dowling says research shows the way small businesses access finance is changing.
In particular, he says, they are turning away from balance-sheet borrowing – that is, bank loans – and turning to non-balance-sheet loans.
“They are undertaking cash-flow financing such as factoring and invoice discounting,” he says. “There has also been a sharp uptick in leasing.”
One reason for this, Dowling says, is that banks still put up hurdles for small business. “A third more SMEs have had to put up their family home as security if they want a loan than had to three years ago,” he says. “Also, banks are lending at the most only to three years, which is not an attractive proposition.”
The main source of funding for small businesses is leasing, Dowling says, followed by receivables financing and then inventory financing. “In terms of growth, receivables financing is growing more quickly,” he says, adding that there are pros and cons in these niche products.
“The products are quite flexible and the big advantage is that they don’t have an impact on the balance sheet. But they can be more expensive and SMEs need to be careful of the quality of their debts. If there are many defaults the provider of the receivables financing will start to escalate the fees they charge.”
Dowling says less than 10 per cent of SMEs use alternative funding products. “You would think based on this that there is a lot of growth out there for these types of products, so SMEs are either not getting the appropriate advice or people don’t know that they are out there,” he says.
While the big four Australian banks all previously offered niche financing products to small business, the Commonwealth Bank of Australia and ANZ have pulled out of the market in the past couple of years, leaving only National Australia Bank and Westpac offering invoice financing.
Jan Barned of Financial Management Trainer helps small businesses improve their financial management. She says it is important for SMEs to understand that there are other financing options apart from banks and credit cards.
“Many SMEs don’t know about these options, when there are many businesses that would benefit from products, such as leasing,” she says. “While they also offer risks they should be considered.”
Barned wrote a book for Small Business Victoria and CPA Australia last year called Achieving Financial Access, which outlines financing options for SMEs. She says businesses tend to use niche products to access cash more quickly but all have advantages and drawbacks.
One of the issues Barned finds with factoring is that if a business passes on invoices to the factor, then it loses ownership of its customer list and may lose the relationship.
“If the factor identifies itself as a debt collector, then your customers may start to think you are in trouble,” she says. “You need to look at what you are trying to finance and seek help regarding alternative products.”
Simon James, partner with HLB Mann Judd, says invoice discounting is popular, especially for seasonal businesses. “They are after capital for the business while they are growing and it is a short-term solution to get them through seasonal peaks,” James says.
However, James is seeing more clients sitting on cash and choosing not to invest. “Banks have pulled out of this space,” he says. “They are putting their customers into other options such as commercial loans and it is getting much harder to attract financing. You need to demonstrate you have a cash flow, but if you have no assets it’s hard to do. This is where invoice discounting can become a type of halfway house, as a financier just has to look at the invoices to see that a company is capable of generating sales.”
He says leasing is another good source of funding and plenty of companies offer it.
“There are shades of risk with leasing as it is an expensive way to get finance, although not if you get the right equipment,” he says. “One mistake is not taking a lease that matches the asset. For example, if you want to use an asset for 10 years but the leasing term is only for four, you might struggle to pay it back within this timeframe.”
He says overdrafts and credit cards are still the main forms of financing. “But I have many clients just sitting on cash who are not willing to take a risk on any business growth,” he says. “Debt levels are going down and businesses appear willing to sacrifice growth to achieve it.”